If Argentina Defaults, Then What?

Argentina faces a Wednesday deadline for more than $500 million in debt payments. It appears unlikely that bondholders will receive their money, bringing to a head a standoff with a separate group of creditors, the so-called “holdout” hedge funds that have refused the country’s two debt-restructuring offers over the past decade.

At the center of the case is a 2012 U.S. District Court ruling that Argentina cannot pay bondholders who accepted the restructuring agreements until it pays the holdouts — a decision that the government contends puts it in a costly legal bind.

Here’s a primer on what might happen should Argentina miss the payments.

Q: Will Argentina go into default?

A: If a debt-service payment isn’t transmitted before midnight on Wednesday evening, Argentina will be in default under the bond documents, legal experts say. Argentina, however, could continue to claim that it isn’t in default. If necessary, a court may have to decide, though legal experts say Argentina’s claim would be thin.

Q: How can Argentina claim it isn’t in default?

A: Argentine officials contend they have met their obligations by transferring money to the trustee. Argentina has deposited the cash with bond trustee Bank of New York Mellon Corp. for an interest payment that was due June 30 on some of the bonds it issued in past restructurings.

But thanks to the 2012 ruling, the bank cannot disburse the money to investors without risking being held in contempt of court. Legal experts point to bond documents that indicate that for a payment to be made, the money must actually be dispensed by the trustee. Just sending money to the trustee “is not sufficient for their payment obligation,” said Jonathan Zonis, a lawyer at Clifford Chance.

Argentina has a 30-day grace period, so in any case the bonds wouldn’t enter default until the end of Wednesday, legal experts said.

Q: What rights do bondholders have?

A: If the payment to investors isn’t made, investors who own affected bonds could submit a demand to “accelerate” payments—that is, a demand that Argentina immediately pay not just interest owed, but all principal, too. An investor, or a group of investors, that owns 25% of a series of outstanding bonds would be eligible to make an acceleration demand.

“The whole logic of acceleration is that the world has changed, and therefore you should have the right to your funds back immediately,” said Brett House, a senior fellow at the Centre for International Governance Innovation, a Canadian think tank.

Q: What would happen if bondholders make a demand for acceleration?

A: A demand for acceleration would turn up the heat on Argentina and make it more worthwhile for those investors to sue, since their monetary claim would be larger. Such a demand could also trigger a “cross-default” provision, meaning investors who own other new bonds would be able to make an acceleration demand even if their bonds weren’t scheduled for a payment on June 30.

Q: Why wouldn’t Argentina pay the old bondholders?

A: The new bonds have an equal-treatment clause, called the Rights Upon Future Offers, or RUFO, clause, that says if old holdout bondholders are offered a better deal, the same offer must be made to the new bondholders. The clause expires at the end of this year.

Analysts say Argentina could argue that any offer wouldn’t be made “voluntarily” because of the litigation, so the clause wouldn’t be triggered. But new bondholders could argue otherwise.

Q: Is a demand for acceleration likely?

A: Mark Weidemaier, an associate professor of law at the University of North Carolina School of Law, said there appears to be little benefit to submitting an acceleration demand.

“The question is whether Argentina views a short-term default as a worse option than cutting a deal now and risking litigation under the RUFO clause,” Mr. Weidemaier said. “As long as you think a country is able and willing to pay you, and it’s all contingent on getting this deal done—I wouldn’t tell you there’s no incentive to try and accelerate but there’s not a particularly compelling reason to do it.”

Q: What happens to Argentina bond prices?

A: Analysts say the immediate reaction on the day of the default could send bond prices plummeting to 50 cents to 60 cents on the dollar from around 86 cents on the dollar right now, as some investors may be forced to sell if they aren’t allowed to hold defaulted bonds. However, few believe bond prices will drop to levels reminiscent of the country’s 2001 default. At that time, Argentine bonds fell to around 30 cents on the dollar.

Q: What happens to credit-default swaps on Argentina bonds?

A: A committee of a derivatives trade group will have to decide whether Argentina has defaulted for purposes of credit-default swaps, a separate product that acts as insurance and pays holders of the swaps if Argentina defaults on the bonds.

Q: Will Argentina’s bond ratings be affected?

A: Standard & Poor’s currently gives Argentina a triple-C-minus long-term rating, which is already “junk” status. If the country fails to pay the June 30 interest payment, S&P said it would lower the rating to “selective default,” meaning the country is meeting its obligations on some bonds but not others.

Moody’s has said that it will consider a missed payment on Wednesday a default, though that wouldn’t trigger an immediate downgrade.